In my last blog post we discussed the financial metric EBITDA and how it has become the core metric in contemporary veterinary practice sales. The rise of this metric as the barometer for the equity value of veterinary ownership raises a logical question:
How does one improve EBITDA at their veterinary practice?
As Earnings Before Interest, Depreciation, Taxes, and Amortization (EBIDTA)is a proxy for profitability, this question boils down to the same one as you’ve always faced as an owner:
How do I ensure that revenue exceeds expenses?
The two methods of increasing profitability are “revenue growth” and “margin expansion”.
The two measures of success in improving profitability are “total EBITDA” and “EBITDA margin”.
Revenue growth
The two primary factors that limit revenue growth are demand and operational capacity. Determining which of these two factors is the limiting factor for your practice is important in driving growth.
When demand exceeds operational capacity, revenue growth can be achieved by maximizing your return on the demand that you’re able to service (pricing optimization) and by increasing operational capacity.
Pricing optimization: The most effective pricing lever that you have access to is your pricing for non-shoppable services. Inventory sales have relatively low pricing elasticity, particularly for preventatives, so focus on the things that leverage you and your team’s skills rather than competing with large online pharmacies. Utilize pricing benchmarks and client feedback to identify what charges need to be increased and which need to be decreased to optimize revenue.
Increasing operational capacity: Increasing the size of your team and the size of your workspace are both ways to increase operational capacity, but the former is particularly challenging in the current job market. If hiring is proving challenging, operational capacity can also be achieved by increasing operational efficiency. Utilizing technology to better leverage your team, fine-tuning your practice’s workflow, and utilizing credentialed technicians to maximize per-DVM productivity can all help you accomplish more when increasing the size of your team isn’t an easy option.
When operational capacity exceeds demand, generating more demand is key. A good marketing strategy will help you differentiate yourself from your local competitors. Adding new services can also allow you to leverage your existing team and facilities to create new categories of demand. When local demand is fully maximized, establishing a secondary or satellite location is an option to continue growth. Because operational capacity and demand fluctuate in relation to each other, it is often impossible (and impractical) to have the exact amount of operating capacity to address the demand. Therefore, having slightly more operational capacity is usually a sweet spot, as it gives you some additional flexibility to serve incremental demand or in case one of your employees calls out sick. However, having too much excess operational capacity usually leads to depressed EBITDA margins (more about EBITDA margins later).
Margin expansion
Margin expansion refers to increasing the percentage of revenue that remains as profit after accounting for all business expenses.
Three mechanisms for driving margin expansion are expense control, improving quality of revenue, and economies of scale.
Expense control: Spending time with your profit and loss statement and comparing to industry benchmarks for similar practices in different expense categories is a high-value exercise that can help you identify areas where your practice might be over-spending. As in medicine, arriving at an accurate diagnosis of the issue is critical in determining the best course of treatment.
Improving quality of revenue: Not all revenue is created equal. Generally, your profit margins will be higher on revenue derived from providing professional services rather than from selling goods, as cost of goods sold (COGS) is typically much higher for the latter. Ensuring that your prices are up to date and maximized within elasticity (start with area-appropriate benchmarks but then adjust to match what works best for your subset of clients) will also help improve quality of revenue and therefore profitability. Improving charge capture is a very powerful tool for improving quality of revenue, as revenue lost due to incorrect invoicing carries through directly to the bottom line.
Economies of scale: Veterinary groups can leverage larger economies of scale that independent practices do not have access to, but that doesn’t mean that there aren’t economies of scale that can be achieved at independent practices too. Most notably, fixed expenses can be blended down by growing your practice’s top line to maximize utilization of the fixed assets that you’re already paying for such as rent and equipment.
For example, a facility with fair market rent of $50,000 means that rent is 10% of revenue at $500,000 of revenue and 5% of revenue at $1,000,000 of revenue. If the clinic had 5% EBITDA margin before growth ($25,000), you would initially expect that doubling revenue would double EBITDA to $50,000. However, thanks to the economy of scale of blending down the clinic’s rent expense by better utilizing the facility, assuming all variable expenses scale without change (all expenses in this example), the EBITDA quadrupled to $100,000 because EBITDA margin expanded from 5% to 10% as the revenue doubled and 5% EBITDA margin was freed from the rent expense category.
Economies of scale are possible with variable expenses too. As your clinic grows, you can pursue more economical bulk ordering while minimizing spoilage of perishable goods.
Stay tuned. My next few blog posts will dive deeper into a few of these topics that I think you will enjoy!
I look forward to hearing your thoughts, please contact me at bill@associatedveterinary.com If you’d like to find out more about how a partnership with AVP could help your practice operate more profitably and enable you to spend more time on your clinical work and less time mulling over profit and loss statements.
Be well,
Dr. Bill
#yourvetpartner